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SIR LTD.

EXECUTIVE SUMMARY

SIR Limited was started in the year 1971. It is a manufacturing firm which produces about 2400 rubber components for the automobile industry. They had 15 customers who were either automobile manufacturers or manufacturers of automobile components. The functional departments of SIR Ltd, are as follows 1. Marketing – Finalises sales plan based on negotiations with customers. They provide the inputs to the product development department. 2. Product development - Prepares new products or changes the existing ones as per customer’s needs. 3. Finance and costing - Get information from production and product development and prepare the Cost Statement, measures product profitability, Overhead recovery rates. 4. Production - Supplies information to product development department regarding machines, capacity, number of hours to be used etc. The problem as stated in this case, is that of an alarming increase in overhead recovery rates as supplied by the Finance and Costing Department. Since the prices are determined by these rates, the Marketing Department is in a fix about how to handle the situation as it will be difficult to convince customers about the price increase and hence they will not be able to provide competitive prices. The company followed the machine hour rate method of overhead recovery. The overhead expenses which are rent, depreciation etc are divided into 1) Fixed Overheads and 2)Variable overheads. The Total costing method using allocation and apportionment is used. The primary problem as can be seen from the Cost statement, is that in the calculation for the overhead expenses, a sum of the fixed and variable overhead expenses has been taken and this sum was divided by the number of machine hours to get the overhead recovery rate. This has resulted in an increase in the overhead recovery rate. The recommended solutions are as follows: 1. The product profitability measurement needs to be changed and the concept of Marginal Costing should be used where Fixed costs are not taken into account. This will lower the overhead recovery rates. 2. The Finance Manager can also consider outsourcing the products carrying negative contribution. But this has the disadvantage of empowering the suppliers and with time, they may rise as competitors and pose a threat to SIR Industries. 3. For products having negative contribution, the company must focus on customer profitability instead of product profitability because a customer purchases more than

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The current strategy of the company is to calculate the price as the sum of costs and profit margin. 2 . 4. Instead the company can fix the price for a particular profit using marginal costing method and look at ways of reducing the costs. The company also needs to rethink its pricing strategy. Therefore while considering all the products sold.one component from the firm. there maybe an overall profit.